«

Despite Rising Construction Costs, Financing Remains Competitive

realtycapital, 15 May 2006, No comments
Categories: News|Views

Chicago, May, 2006 — Construction costs continue spiraling because of rising energy costs and material shortages.  For example, during the past three years asphalt increased nearly 50%, concrete more than 25%, steel over 75%, and diesel fuel more than doubled.  It’s safe to say that overall construction costs have risen more than 20% on a combined basis.

Developers are adapting quickly.  Tactics include project redesign, scheduled delays and even cancellations.  Common redesign elements may mean removal of underground parking or more spartan tenant improvements.  Scheduled delays are more risky tactics allowing developers to “wait and see” whether prices will drop.  Of course, cancellations are the most drastic measures.   In other words, developers must manage the expectations of sellers, equity investors, lenders, tenants and suppliers during such a volatile time.

On the real estate capital side of the development budget, some land and investors owners are realigning pricing expectations.  Examples include contributing the land into the deal as an equity component in the hopes of appreciating cash flow upon project completion.  Still, others are paying more equity and accepting lower overall returns in anticipation of appreciation  (Returns on cost may be as low as 7%).

Good news on some cost components.  In particular, construction and permanent financing costs are favorable.  Interest rates remain near  historic lows.  Furthermore, the cost of fixed-rate, permanent debt based on forward-delivery timetables is extremely competitive.  Developers can capture forward-delivery pricing as low as two basis points a month, translating to about a quarter point higher rate to secure financing 18 months out.  In contrast, such pricing was more than double within the past couple of years.

Construction loan pricing for most institutional-grade projects in excess of $20 million range is as low as 130 basis points over 30-day LIBOR.  Permanent financing based on funding as far out as 24 months is available starting at 125 basis points over comparable-term treasuries.

Nat Zvislo, research director for the Real Estate Capital Institute, suggests that “while construction costs are rising, ultimately those costs will translate to higher rents.  Existing project-pricing will also benefit from better spreads between replacement costs and new development.”

The Real Estate Capital Institute monitors commercial property debt and equity trends.  Daily interest-rate news is available by calling the Real Estate Capital Rateline at 773-227-4825.  For more extensive research information, please visit www.reci.com.

»

Comments

Leave a Reply:

Name *

Mail (hidden) *

Website

Chicago, Illinois, August 2, 2010 – Mid-year key economic indicators point to a more moderate recovery.  During July, benchmark treasuries moved within a quarter point range and settled lower by about 20 basis points for five-year notes, while ten-year notes moved down less than 10 basis points, respectively.  Mortgage spreads continued to barely tighten, netting slightly lower overall rates. Throughout the first half of the year, lenders have been scouring the realty markets in search of performing projects with stabilized cash flow.  Yet limited opportunities may be found.  Simultaneously, scant funding options are available for projects without cash flow performance.   Few capital sources reach for deals on longer-term cash flow projects, unless substantial equity exists.  With mortgage rates starting in the mid-4% range for longer term debt of seven years or greater, borrowers are migrating from floating-rate to fixed-rate debt.  As rates are at historical lows, focus on loan terms - other than pricing - include the following:  Loan-to-value sizing dominates underwriting funding limits, as debt service coverage ratios are relatively high due to low rates Subordination and non-disturbance agreements are more important to lenders as various players in the capital stack (e.g., mezzanine and preferred equity) take on new positions in situations where developer equity is reduced or eliminated Real estate tax and insurance collection conditions are more stringent, with lenders seeking tighter control in case of default Property insurance carriers must meet higher standards due to default within the industry Unauthorized transfers are no longer covered by most title policies, adding additional recourse carveouts Skip Perry, Real Estate Capital Institute advisory board member notes that "lenders want quality loans, and are willing to sacrifice yield in return for safety of principal."  He suggests, "conservatively underwritten income-property loans are precious commodities capturing premium pricing and terms.”